C Corp Asset Sale

[David]

C Corp sold the business in an asset sale. The Corp has an NOL carry forward, negative retained earnings and additional paid in capital. There is no capital stock shown on the balance sheet.

This is the first C Corp asset sale I have done.

To close out the corp do I simply zero out all asset, liabilty and equity accounts  offsetting them to gain from sale?

The asset sale is allocated to AR, AP, inventory, fixed assets, 197 intangibles (such as going concern, workforce in place, non-compete covenant, etc.) and goodwill.

Regarding reporting the sale on the 1120 - I know that the sales allocated to fixed assets is reported against each asset's adjusted basis to report gain or loss.

Do I report each allocated sale on Form 4797 for the other categories above, even those that have no cost, such as the 197 intangibles and goodwill? How do I report the other assets, liabilities, additional paid in capital and negative retained earnings?

The sale proceeds were used to pay off debt, operating expenses and pay back the additional paid in capital for the 2 shareholders. The shareholders took no other proceeds.

The NOL carry forward will offset the gain from sale of assets. So there will be no tax due from the corporation or shareholders. Is this correct?

One last thing - even though there are no assets or additional paid in capital, the shareholders don't want to dissolve the corporation since there will still be an NOL. They want time to decide if they can do something else in the corporation and take advantage of the NOL in the future. 

Is this an option since there are no assets or paid in capital?

Thanks for your help.

 

[David]

OK, I think I better understand what should happen in this situation. I'd like to confirm my understanding.

Only the assets and AP listed in the purchase agreement are closed out against the gain from sale. Any other assets and liabilities such as prepaid insurance, debt and accrued expenses are considered handled from the cash received from the sales proceeds and do not impact the gain from sale.

The payments to the shareholders for their additional paid in capital is considered paid from the sales proceeds and do not impact the gain from sale.

If the assets and AP are different than the amounts listed in the purchase agreement, are these differences used to calculate the gain or loss from sale? For instance, the purchase agreement lists inventory at $66K. The actual amount on the date of sale was $20K. Is the $46K considered gain from sale?

If some assets or liabilities not listed in the asset agreement, such as prepaid insurance or accruals, have a remaining balance I am thinking that balance will stay on the balance sheet? If all assets and liabilities need to be zeroed out, what are the closing entries?

Now it appears that the NOL carryforward will not offset the gain from sale and the corporation will have a tax liability. Therefore, won't there still be a balance in the equity section showing the negative retained earnings, current year loss and the gain from sale?

I thought the year end balance sheet should be zero since the assets have been sold and the shareholders have been paid back for their capital. What am I missing here?

Thanks for your help.

[kcjenkins]

Here are a few links that might help:

http://www.law360.com/articles/456306/assessing-tax-consequences-of-asset-sales

http://www.fraziercapital.com/books/guide/15.pdf

Just remember,  the corporation itself is taxed on any gain from selling the assets to the buyer. Second, the shareholders are taxed on proceeds from the corporate liquidation that frequently ensues.  

[jklcpa]

That's a lot of questions!  Here are some pointers that should put you moving in the proper direction.

You must use Form 8594 to report the breakdown of the selling price into the asset classes. The purchaser should also be filing this and the numbers reported on the purchaser's and seller's forms 8594 returns must agree. Each of the items sold within each class will be reported on the corporate return. Report them as you would if they were sold in individual transactions and don't get hung up on this being an entire sale of the business...at least not yet.  It may be helpful to make a schedule of everything that was sold and it's net book value so that you know what the gain should be once you start to create the tax return.  Use form 4797 where appropriate and use the appropriate sections depending on whether the assets were held for less and one year or over one year. The final depreciation may be different than you expect if you have a short period tax year and considering the dispositions. Watch for any assets retained or not sold to the new entity (common example is an automobile in the corporate name that is distributed to a shareholder), any obsolete equipment and fixtures, and any leasehold improvements that might be abandoned if the seller isn't going to use the same location.

Sale of the goodwill and intangibles will be ordinary income to the corporation. 

You asked about inventory. You have a selling price and you have cost basis on the books. The difference is ordinary income to the corporation.  It's not really different than the company selling inventory at a mark-up over cost in their ordinary course of business.

Once you've accounted for all of the items sold, then you have to figure out what to do with the remaining items. You mentioned prepaid expenses like insurance. Was that coming from the starting book balance at the beginning of the year? Were the policies cancelled?  If so, you would write that off if the corporation has cancelled the policies and the corporation won't be continuing. Same thing with accrued expenses. Were they from the beginning balances? If so, those should be reversed during the current year.  If the corporation used the some of the sale proceeds to pay off creditors and payroll taxes, the only payables remaining should be any corporate income tax liability, if any, from this final period.

Once you've accounted for everything that was sold and dealt with those prepayments and accruals, then you'll also have to consider any assets that have been distributed to the stockholders, if any. You said that only cash was distributed. I hope that is correct because if there was any tangible appreciated asset distributed to a stockholder, that would be distributed at FMV and the corporation would record a gain on that distribution as well. It is at this point that you should be able to arrive at income before the NOL. You'll apply the NOL taking into consideration any adjustments for changes in limitations due to the use of that NOL. One such example of that would be a possible reduction in allowable deductible contributions deduction because of application of the NOL.  Any remaining NOL not used by the corporation in its final year will be lost. 

Once you've accounted for everything that has been sold, distributed, or abandoned, you should have accounted for all of the balance sheet items, and then it's time to break down what each stockholder received as liquidating distributions to properly file the Forms 1099-DIV.  The cash paid would be reported in box 8 of Form 1099-DIV, and any non-cash liquidating distributions are reported at FMV in box 9.  These figures are reported on the personal returns of the stockholders on Form 8949 as sale of the ownership interest in the corporation, and the individual stockholders would report any basis against this to arrive at the amount of their respective capital gains on this transaction. 

Hopefully that gives you some idea of how to get started and if I missed something, I hope others will chime in and will add to this. 

[David]

Thanks so much KC and Judy. That helps a lot.

The accountant closed out most of the accounts to a holding account and named the account Goodwill. My hope is, as I weed through that account, all of the assets and liabilities that weren't part of the sale have been zeroed out from normal operating transactions.

If I find that the accountant just zeroed out accounts with ending balances to the holding account, then shouldn't those accounts be netted against the gain/loss from sale of assets?

No 1099-DIVs were filed. Since the shareholders only received the capital they paid in and there is no gain to the shareholders, is it Ok to just let this go? There was an amount left in escrow that was paid to the shareholders in 2015. I will make sure that last part gets reported on a 1099-DIV.

Thanks for your help.   

[jklcpa]

1 hour ago, David said:

The accountant closed out most of the accounts to a holding account and named the account Goodwill. My hope is, as I weed through that account, all of the assets and liabilities that weren't part of the sale have been zeroed out from normal operating transactions.

If I find that the accountant just zeroed out accounts with ending balances to the holding account, then shouldn't those accounts be netted against the gain/loss from sale of assets?

That's creative. You need to go through that holding account piece by piece and look at all of the entries.  An account to be written off wouldn't go to a holding account or against goodwill, it would be written off against where it would ordinarily be written off to. Example, ppd insurance would be written off against insurance expense.  BOY accrued payroll that hadn't been reversed would be credited against payroll expense. Accounts receivable that are uncollectible and that weren't sold would be written off as a bad debt.  Handle these like you would at any other time, not against anything to do with the sale.

Separating the assets into their various asset classes (as used on the form 8594) is basically the residual method of valuing the various components of a sale of this type. Values are negotiated between the buyer and seller moving down through the classes one by one, and anything left over and unassigned is thrown into goodwill. That's not something you or the bookkeeper comes up with.  Unless there is goodwill on the books of this company, the goodwill that is assigned in this sales contract will be 100% profit from that component of the sale, taxed as ordinary income with no cost basis against it.

[BulldogTom]

I have a question on this....they are not done with the corp.  How can they do the distributions of capital?  Wouldn't that be a dividend?  Double taxation? 

Tom
Newark, CA

[David]

Judy,

Thanks again for your help.

Yes, I understand the goodwill piece. The accountant just called the holding account Goodwill, understanding that it wasn't really goodwill.

That makes sense to go through each account. 

The sale of $1,200K was booked as follows: $1,145K to cash, $55K Other Rec. (this is escrow paid in 2015), and $1,200K to gain from sale.

I'd like input on 2 accounts to make sure I understand you correctly -

Inventory balance was $20K and the purchase agreement allocated sales for inventory at $66K. This should be reported by crediting the inventory account for $20K and debiting the gain from sale for $20K which results in a $46K gain. The tax return should show a sales price of $66K and cost of $20K for a total gain of $46K. This makes sense and the book gain matches the tax gain.

However, I'm having a little trouble with AP - 

AP had a balance of $249K as of the sale date and the purchase agreement assigned a value of $10K. Even during the negotiation timeframe AP was never that low. The company continued paying accounts payable down to zero after the sale date (March) through August using the cash they had on hand plus the $1,145K cash received from the sale.

Since the $1,200K sale price reported as gain from sale on the books includes the $10K sales allocated to AP, there is a $10K gain for AP reported on the books. However, on the tax return the sale price should be reported as $10K and the cost should be reported as $10K which nets to no gain or loss.

I shouldn't have to do anything regarding the difference between the $249K AP balance and the $10K sale price since all of the AP was paid by August and the year end balance is zero, correct?

I can't figure out why the $10K discrepancy exists. Any ideas?

Thanks.

 

[jklcpa]

2 hours ago, BulldogTom said:

I have a question on this....they are not done with the corp.  How can they do the distributions of capital?  Wouldn't that be a dividend?  Double taxation? 

Tom
Newark, CA

There's always double taxation with selling a C corp structured as an asset sale when there are distributions paid out to the stockholders, no matter whether those distributions represent liquidating distributions, return of capital, or ordinary dividends, unless the amount distributed is so small that it doesn't even cover the stockholder's basis. The label that is put on it will only affect where it is reported and the rate at which those are taxed on the stockholders' personal returns.

It sounds like David will find out soon enough whether or not there is any remaining NOL worth keeping the corporation alive.  There are risks to keeping the corporation alive, and those are future claims by creditors or other parties that may file claims against the corporation. Besides a purchaser getting a step-up in basis in an asset sale, this is another reason why the buyers favor sales structured as asset sales over simply purchasing the stock.

 

[jklcpa]

22 minutes ago, David said:

Judy,

Thanks again for your help.

Yes, I understand the goodwill piece. The accountant just called the holding account Goodwill, understanding that it wasn't really goodwill.

That makes sense to go through each account. 

The sale of $1,200K was booked as follows: $1,145K to cash, $55K Other Rec. (this is escrow paid in 2015), and $1,200K to gain from sale.

I'd like input on 2 accounts to make sure I understand you correctly -

Inventory balance was $20K and the purchase agreement allocated sales for inventory at $66K. This should be reported by crediting the inventory account for $20K and debiting the gain from sale for $20K which results in a $46K gain. The tax return should show a sales price of $66K and cost of $20K for a total gain of $46K. This makes sense and the book gain matches the tax gain.

However, I'm having a little trouble with AP - 

AP had a balance of $249K as of the sale date and the purchase agreement assigned a value of $10K. Even during the negotiation timeframe AP was never that low. The company continued paying accounts payable down to zero after the sale date (March) through August using the cash they had on hand plus the $1,145K cash received from the sale.

Since the $1,200K sale price reported as gain from sale on the books includes the $10K sales allocated to AP, there is a $10K gain for AP reported on the books. However, on the tax return the sale price should be reported as $10K and the cost should be reported as $10K which nets to no gain or loss.

I shouldn't have to do anything regarding the difference between the $249K AP balance and the $10K sale price since all of the AP was paid by August and the year end balance is zero, correct?

I can't figure out why the $10K discrepancy exists. Any ideas?

Thanks.

 

 

David, I can't tell you where that discrepancy is coming from. Is there a math error or typo somewhere in the allocations or in your calculations?  Do the numbers allocated to each class of assets add up to the total. I've seen stranger things, typos....

An asset sale is just that, sale of assets, and I've never seen any sale that included an amount allocated to accounts payable. The only time I've seen debt being picked up by the purchaser is if an asset is encumbered by a loan, and then the lien follows the asset. The same is true of liabilities that are secured by specific assets, and those liabilities effectively follow the assets unless the seller agrees to pay them off.  Does the allocation refer to any specific debt?

[David]

The allocation says "Debt (Current AP) and nets this against AR.

Yes, the numbers allocated to each class of assets add up to the total. 

Yeah, I just can't figure out why the books will show the $10K gain for the allocated sale of AP. 

Is my treatment of inventory correct?

Thanks.

 

[jklcpa]

33 minutes ago, David said:

The allocation says "Debt (Current AP) and nets this against AR.

Yes, the numbers allocated to each class of assets add up to the total. 

Yeah, I just can't figure out why the books will show the $10K gain for the allocated sale of AP. 

Is my treatment of inventory correct?

Thanks.

 

 

I would include the $10K price in with the AR in the class 3 group, but remember I said that the 8594s for the seller and purchaser much match.  It sounds like this asset sale includes working capital items. Please check the sale docs to see if those prepaid expenses I mentioned earlier and the accrued expenses are included. As I said before, if insurance policies were cancelled or if these items were only due to them being from the beginning balance that will reverse, then maybe there's nothing to include, but there might be.  That's why you have to ask what happened with each item in the sale and on the company's balance sheet.

Inventory sold for $66, net book value $20, ordinary income from its sale $46.  I thought I answered that before.

 

[jklcpa]

1 hour ago, David said:

Is my treatment of inventory correct?

Thanks.

 

 

You know that doesn't go on the 4797, right? (because you keep saying "gain").  Remember I said not to get hung up in the fact that this is a sale of the entire group of assets, that you should report the individual items as you would if sold individually.  What I meant by that is to use the proper forms and places on the return where those items sold would ordinarily be properly reported.   The SP of the inventory will be included in gross revenues, and the decrease in the inventory down to -0- at year end will effectively include the $20K of the inventory cost in the COS section of the tax return.  The $46K of ordinary income from the sale of inventory will be included as part of the gross profit on the corporate tax return.

[David]

Thanks for clarifying that. I thought any assets and liabilities included in the asset sale were included on the 4797.

So it appears that the only asset categories that will be reported on the 4797 will be the fixed assets, goodwill and intangibles?

Thanks.

[kcjenkins]

They did not SELL the AP, David, although it sounds like they agreed to pay them all off, from the proceeds, and that was merely listed in the sales agreement to protect the buyers.  There should be neither a gain nor a loss from paying off their debts.